Solution Manual For Survey of Accounting 8th Edition Carl S Warren

Solution Manual for Survey of Accounting, 8th Edition Carl S.
Warren
Solution Manual for Survey of Accounting, 8th

Edition Carl S. Warren
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CHAPTER 6
RECEIVABLES AND INVENTORIES
CLASS DISCUSSION QUESTIONS
1. Receivables are normally classified as Additional costs, such as direct labor and factory
(1) accounts receivable, (2) notes re- overhead, must be added to materials during
ceivable, or (3) other receivables. production. The work-in-process inventory ac-
2. Transactions in which merchandise is count accumulates material, labor, and over-
sold or services are provided on credit head costs incurred during production. At the
generate accounts receivable. completion of production, the costs in work-in-
3. a. Current Assets process are transferred to the finished goods in-
ventory account. Upon sale, the costs in finished
b. Investments
goods are transferred to cost of goods sold to be
4. Examples of other receivables include matched against the revenue from sale. Since
interest receivable, taxes receivable, retailers only purchase goods for resale, they
and receivables from officers or em- use a single inventory account, Inventory. Upon
ployees.
sale, the inventory costs are transferred to cost
5. Carter’s should use the direct write-off of goods sold to be matched against the reve-
method because it is a small business nue from sale. Thus, accounting for the sale of
that has a relatively small number and completed goods is similar for both types of
volume of accounts receivable. firms.
6. The allowance method 11. No, they are not techniques for determining
7. Contra asset physical quantities. The terms refer to cost flow
8. The accounts receivable and allowance assumptions, which affect the determination of
for doubtful accounts may be reported at the costs assigned to items sold during the period
the net amount of $428,200 ($475,000 – and that remain in inventory at the end of the
$46,800) in the Current Assets section period.
of the balance sheet. In this case, the 12. No, the term refers to the flow of costs rather
amount of the allowance for doubtful ac-
than the items remaining in the inventory. The
counts should be shown separately in a
inventory cost is composed of the earliest acqui-
note to the financial statements or in pa-
rentheses on the balance sheet. Alter- sitions costs rather than the most recent acquisi-
natively, the accounts receivable may tions costs.
be shown at the gross amount of 13. a. FIFO c. FIFO
$475,000 less the amount of the allow- b. LIFO d. LIFO
ance for doubtful accounts of $46,800,
thus yielding net accounts receivable of 14. FIFO
$428,200. 15. LIFO. In periods of rising prices, the use of LIFO
9. (1) The percentage rate used is exces- will result in the highest cost of goods sold, the
sive in relationship to the volume of lowest taxable income, and the lowest income
accounts written off as uncollectible; tax expense.
hence, the balance in the allowance 16. The LIFO reserve is the difference between the
account is excessive. FIFO and LIFO inventory valuation. The analyst
(2) A substantial volume of old uncol- will adjust earnings to what they would have
lectible accounts is still being carried been under FIFO. This is because the liquidation
in the accounts receivable account. of a LIFO reserve abnormally inflates gross profit
10. Manufacturing firms must accumulate and net income.
the costs for making product. The costs 17. Current Assets
for making product include materials, 18. By a notation next to “inventory” on the balance
which are included in materials inventory. sheet or in a note to the financial statements.
173
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EXERCISES
E6–1
Accounts receivable from the U.S. government are significantly different from re-
ceivables from commercial aircraft carriers such as Delta and United. For example,
U.S. government receivables often involve complex contracts, but are backed by
the full faith and credit of the government. In contrast, company receivables have
more credit risk. Thus, Boeing should report each type of receivable separately.
In a recent filing with the Securities and Exchange Commission, Boeing reports the
receivables together on the balance sheet but discloses each receivable separately
in a note to the financial statements.
E6–2
Due Date Interest Due at Maturity

a. Feb. 14 $250 [$50,000 × 0.06 × (30/360)]
b. June 30 $270 [$27,000 × 0.04 × (90/360)]
c. Aug. 6 $225 [$30,000 × 0.06 × (45/360)]
d. Dec. 28 $2,400 [$90,000 × 0.08 × (120/360)]
e. Dec. 5 $500 [$72,000 × 0.05 × (50/360)]
E6–3
a. MGM: 15.9% ($89,602,000 ÷ $562,947,000)
b. IBM: 3.6% ($336,000,000 ÷ $9,426,000,000)
c. Casino operations experience greater bad debt risk since it is difficult to

control the creditworthiness of customers entering the casino. In addition,
individuals who may have adequate creditworthiness could overextend them-
selves and lose more than they can afford if they get caught up in the excite-
ment of gambling. In contrast, IBM’s customers are primarily other businesses.
Note to Instructors: In a separate note in its 10-K SEC filing, MGM disclosed
that its casino accounts receivables of $307,152,000 have an estimated allow-
ance for doubtful accounts of $84,397,000, which as a percentage of casino
receivables is 27.5% ($84,397,000 ÷ $307,152,000). The remaining receivables
of MGM are primarily related to its hotel operations.
174
E6–4
Collected $5,000
Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Statement
Cash + Receivable
Mar. 18. 5,000 (5,000)
Statement of Cash Flows

Mar. 18. Operating 5,000
Wrote-off $10,000
Balance Sheet
Cash Flows Retained Statement
Accounts Receivable = Earnings
Mar. 18. (10,000) (10,000) Mar. 18.
Income Statement
Mar. 18. Bad debt
expense (10,000)
Reinstated Account
Balance Sheet
Aug. 29. 10,000 10,000 Aug. 29.
Income Statement
Aug. 29. Bad debt
expense 10,000
175
E6–4, Concluded
Collected $10,000
Balance Sheet
Cash + Receivable
Aug. 29. 10,000 (10,000)
Aug. 29. Operating 10,000
E6–5
Collected $2,500
Balance Sheet
Cash + Receivable
July 3. 2,500 (2,500)
July 3. Operating 2,500
Wrote-off $11,000
Balance Sheet
Cash Flows Accounts Allowance for Statement
Receivable – Doubtful Accounts
July 3. (11,000) 11,000
176
E6–5, Concluded
Reinstated Account
Balance Sheet
Oct. 8. 11,000 (11,000)
Collected $11,000
Balance Sheet
Cash + Receivable
Oct. 8. 11,000 (11,000)

Oct. 8. Operating 11,000
177
E6–6
a.
Balance Sheet
Cash Flows Accounts Retained Statement
Receivable = Earnings
(13,000) (13,000)
Income Statement
Bad debt
expense (13,000)
b.
Balance Sheet
Cash Flows Accts. Allowance for Statement
Rec. – Doubtful Accounts
(13,000) 13,000
E6–7
Estimated balance of Allowance for Doubtful Accounts: $97,400
Computed as shown below.
Estimated
Uncollectible Accounts
Age Interval Balance Percent Amount
Not past due ............................................... $1,850,000 1% $18,500
1–30 days past due .................................... 750,000 2 15,000
31–60 days past due .................................. 100,000 6 6,000
61–90 days past due .................................. 60,000 14 8,400
91–180 days past due ................................ 45,000 60 27,000
Over 180 days past due............................. 25,000 90 22,500
Total....................................................... $2,830,000 $97,400
178
E6–8
Balance Sheet
Cash Flows Allowance for Retained Statement
– Doubtful Accounts = Earnings
Dec. 31. (84,100) (84,100) Dec.31.
Income Statement
Dec. 31. Bad debt
expense (84,100)
Note: $84,100 = $97,400 – $13,300
E6–9
a. $172,500 ($34,500,000 × 0.005) c. $258,750 ($34,500,000 × 0.0075)

b. $181,500 ($200,000 – $18,500) d. $264,000 ($255,000 + $9,000)
E6–10
$108,200 [$120,000 + $16,000 – ($2,780,000 × 1%)]
E6–11
a. $130,000 [$140,000 + $20,000 – ($3,000,000 × 1%)]
b. $21,800 [($27,800 – $16,000) + ($30,000 – $20,000)]
179
E6–12
a. The three different inventories accumulate manufacturing costs as the prod-

uct is being produced. Costs flow through these accounts until the product is
sold, and the cost is matched on the income statement as cost of goods sold,
shown as follows:
Materials Work-in-Process Finished Goods Cost of
Inventory Inventory Inventory Goods Sold
b. The materials inventory includes the cost of purchased parts and materials
needed to manufacture wireless communication devices. Work-in-process in-
ventory accumulates direct materials, direct labor, and factory overhead
costs that are incurred during production. The finished goods inventory in-
cludes the direct labor, direct materials, and factory overhead costs for com-
pleted product.
180
E6–13
a. The asset categories reflect the life cycle of a film. The initial “In develop-
ment” costs are associated with efforts to develop a new film. These costs
would include the salaries of writers and other creative people to develop film
concepts and ideas. Once a film is accepted for production, the costs are rec-
lassified as “In production” (in process). Additional production costs, including
salaries for actors and actresses, are now accumulated. Once a film is released
(completed), the costs are transferred to the “In release” and product inventory
categories.
b. The description above sounds similar to a manufacturing firm. Raw materials

(in development) are transferred to work in process (in process), then to fi-
nished goods (completed). Thus, the reclassification of costs through differ-
ent asset categories as the film becomes more complete is similar to a manu-
facturing firm. However, with manufactured product, once the product is sold,
the costs are shown on the income statement as cost of goods sold. In other
words, all of the costs are matched against the revenue. For DreamWorks,
when a film is released, the costs of the completed film do not all immediately
flow to the income statement. Rather, the costs are classified as an asset,
termed “released,” and expensed (written off) over a short time period
(around three years). This reflects the belief that films can generate revenue
longer than the year in which they are first released. This application of the
matching principle is reasonable since such films earn revenues on television,
in foreign markets, and in DVD sales.
E6–14
a. $24,750 (45 units at $550)

b. $19,080 [(27 units × $400) + (18 units × $460) = $10,800 + $8,280]
c. $22,320 (45 units at $496; $99,200 ÷ 200 units = $496)
Cost of merchandise available for sale:
27 units at $400 ......................................................... $10,800
54 units at $460 ......................................................... 24,840
63 units at $520 ......................................................... 32,760
56 units at $550 ......................................................... 30,800
200 units (at average cost of $496) ........................... $99,200
181
E6–15
Cost
Ending Cost of Goods
Inventory Method Inventory Sold
a. FIFO ........................................ $37,620 $108,630
b. LIFO ........................................ 32,400 113,850
c. Weighted average ................. 35,100 111,150
Cost of merchandise available for sale:
21 units at $1,800 ..................................................... $ 37,800
29 units at $1,950 ..................................................... 56,550
10 units at $2,040 ..................................................... 20,400
15 units at $2,100 ..................................................... 31,500
75 units (at average cost of $1,950) ........................ $ 146,250
a. First-in, first-out:
Inventory:
15 units at $2,100 ..................................................... $ 31,500
3 units at $2,040 ..................................................... 6,120
37 units ..................................................................... $ 37,620
Inventory sold:
$146,250 – $37,620.................................................... $108,630
b. Last-in, first-out:
Inventory:
18 units at $1,800 ..................................................... $ 32,400
Inventory sold:
$146,250 – $32,400 .................................................... $113,850
c. Weighted average cost:
Inventory:
18 units at $1,950 ($146,250 ÷ 75 units) .................. $ 35,100
Merchandise sold:
$146,250 – $35,100.................................................... $111,150
182
E6–16
1. a. FIFO ending inventory > (greater than) LIFO ending inventory

b. FIFO cost of goods sold < (less than) LIFO cost of goods sold
c. FIFO net income > (greater than) LIFO net income
d. FIFO income tax > (greater than) LIFO income tax
2. In periods of rising prices, the net income shown on the company’s tax return
would be lower under LIFO than under FIFO; thus, there is a tax advantage of
using LIFO.
Note to Instructors: The federal tax laws require that if LIFO is used for tax pur-
poses, LIFO also must be used for financial reporting purposes. This is known
as the LIFO conformity rule. Thus, selecting LIFO for tax purposes means the
company’s reported net income will also be lower than if FIFO had been used.
Companies using LIFO believe the tax advantages from using LIFO outweigh any
negative impact of reporting a lower net income to shareholders.
E6–17
1. The interest receivable should be reported separately as a current asset. It

should not be deducted from notes receivable.
2. The allowance for doubtful accounts should be deducted from accounts

receivable.
A corrected partial balance sheet would be as follows:
ZABEL COMPANY
Balance Sheet
December 31, 20Y4
Assets
Current assets:
Cash ............................................................................ $ 75,000
Notes receivable ......................................................... 115,000
Accounts receivable .................................................. $475,000
Less allowance for doubtful accounts ................ (11,150) 463,850
Interest receivable ...................................................... 9,000
183
E6–18
Total
Market
Value per
Cost Unit (Net
Inventory per Realizable
Product Quantity Unit Value) Cost Market LCM
Adams 100 $140 $125 $ 14,000 $ 12,500 $ 12,500
Coolidge 375 90 112 33,750 42,000 33,750
McKinley 220 60 59 13,200 12,980 12,980
Garfield 900 120 115 108,000 103,500 103,500
Lincoln 626 140 145 87,640 90,770 87,640
Total $256,590 $261,750 $250,370
E6–19
The inventory would appear in the Current Assets section, as follows:

Inventory—at lower of cost (FIFO) or market ............................... $250,370
Alternatively, the details of the method of determining cost and the method of
valuation could be presented in a note.
184
PROBLEMS
P6–1
1.
A B C D E F G H
1 Aging-of-Receivables Schedule
2 December 31, 20Y7
3 Days Past Due
Not Past Over
4 Customer Balance Due 1–30 31–60 61–90 91–120 120
5 AAA Beauty 27,500 27,500
6 Amelia’s Wigs 3,750 3,750
30 Zim’s Beauty 1,650 1,650

31 Totals 1,100,000 750,000 180,000 75,000 45,000 22,000 28,000
32 Percent uncollectible 1% 3% 7% 16% 40% 90%
Estimate of
33 uncollectible accounts 59,350 7,500 5,400 5,250 7,200 8,800 25,200
2.
Balance Sheet
20Y7 20Y7
Dec. 31. (57,100)* (57,100) Dec. 31.
Income Statement
20Y7 Bad debt
Dec. 31. expense (57,100)
*$57,100 = $59,350 – $2,250
185
P6–1, Continued
3.
Balance Sheet
20Y7 20Y7
Dec. 31. (60,000)* (60,000) Dec. 31.
Income Statement
20Y7 Bad debt
Dec. 31. expense (60,000)
*$60,000 = $2,400,000 × 2.5%
4.
Balance Sheet
20Y8
Mar. 4. (2,950) 2,950
186
P6–1, Continued
5.
Reinstated Account
Balance Sheet
20Y8
Aug. 17. 2,950 (2,950)
Collected $2,950
Balance Sheet
Cash + Receivable
20Y8
Aug. 17. 2,950 (2,950)
20Y8
6. a.
Wrote-off of Account
Balance Sheet
20Y8 20Y8
Mar. 4. (2,950) (2,950) Mar. 4.
Income Statement
20Y8 Bad debt

Mar. 4. expense (2,950)
187
P6–1, Concluded
6. b.
Reinstated Account
Balance Sheet
20Y8 20Y8
Aug. 17. 2,950 2,950 Aug. 17.
Income Statement
20Y8 Bad debt
Aug. 17. expense 2,950
Collected $2,950
Balance Sheet
Cash + Receivable
20Y8
Aug. 17. 2,950 (2,950)

20Y8
188
P6–2
1.
a. b.
Addition to Allowance Accounts Written
Year for Doubtful Accounts Off During Year
20Y2 $31,250 ($12,500,000 × 0.0025) $18,450 ($31,250 – $12,800)

20Y3 31,500 ($12,600,000 × 0.0025) 21,300 ($12,800 + $31,500 – $23,000)
20Y4 32,000 ($12,800,000 × 0.0025) 21,000 ($23,000 + $32,000 – $34,000)
20Y5 32,500 ($13,000,000 × 0.0025) 17,500 ($34,000 + $32,500 – $49,000)
2. a. The estimate of ¼ of 1% of credit sales may be too large since the allow-
ance for doubtful accounts has steadily increased each year. The increas-
ing balance of the allowance for doubtful accounts may also be due to the
failure to write off a large number of uncollectible accounts. These possi-
bilities could be evaluated by examining the accounts in the subsidiary
ledger for collectibility and comparing the result with the balance in the
allowance for doubtful accounts.
Note to Instructors: Since the amount of credit sales has been fairly uniform over
the years, the increase cannot be explained by an expanding volume of sales.
b. The balance of Allowance for Doubtful Accounts that should exist at

December 31, 20Y5, can only be determined after all attempts have been
made to collect the receivables on hand at December 31, 20Y5. However,
the account balances at December 31, 20Y5, could be analyzed, perhaps
using an aging schedule, to determine a reasonable amount of allowance
and to determine accounts that should be written off. Also, past write-offs
of uncollectible accounts could be analyzed in depth to develop a reason-
able percentage for future adjusting entries. Caution must be exercised,
however, in using historical percentages. Specifically, inquiries should be
made to determine whether any significant changes between prior years
and the current year may have occurred, which might reduce the accuracy
of the historical data. For example, a recent change in credit-granting pol-
icies or changes in the general economy (such as entering a recessionary
period) could reduce the usefulness of analyzing historical data.
Based on the preceding analyses, a recommendation to decrease the
annual rate charged as an expense may be in order (perhaps EquiPrime
Co. is experiencing a lower rate of uncollectibles than is the industry
average), or perhaps a change to the “estimate based on analysis of
receivables” method may be appropriate.
189
P6–3
1. Bad Debt Expense

Increase Balance of
Expense Expense (Decrease) Allowance
Actually Based on in Amount Account,
Year Reported Estimate* of Expense End of Year
1 $ 5,000 $ 11,500 $ 6,500 $ 6,500
2 9,000 23,750 14,750 21,250
3 23,000 45,000 22,000 43,250
4 37,500 48,000 10,500 53,750
*Determined by multiplying sales by 0.005 as follows:

Year 1: $11,500 = $2,300,000 × 0.005
Year 2: $23,750 = $4,750,000 × 0.005
Year 3: $45,000 = $9,000,000 × 0.005
Year 4: $48,000 = $9,600,000 × 0.005
2. Yes. The actual write-offs of accounts originating in the first two years are
reasonably close to the expense that would have been charged to those years
on the basis of ½% of sales. The total write-off of receivables originating in
the first year amounted to $11,000 ($5,000 + $4,000 + $2,000), as compared
with bad debt expense, based on the percentage of sales, of $11,500. For the
second year, the comparable amounts were $22,500 ($5,000 + $12,000 +
$5,500) and $23,750.
190
P6–4
1. First-In, First-Out Method

Model Quantity Unit Cost Total Cost
A10 4 $ 76 $ 304
2 70 140
B15 6 184 1,104
2 170 340
E60 5 70 350
G83 9 259 2,331
J34 15 270 4,050
M90 3 130 390
2 128 256
Q70 7 180 1,260
1 175 175
Total .................................................................. $10,700
2. Last-In, First-Out Method

A10 4 $ 64 $ 256
2 70 140
B15 8 176 1,408
E60 3 75 225
2 65 130
G83 7 242 1,694
2 250 500
J34 12 240 2,880
3 246 738
M90 2 108 216
2 110 220
1 128 128
Q70 5 160 800
3 170 510
Total .................................................................. $ 9,845
191
P6–4, Concluded
3. Weighted Average Cost Method

A10 6 $ 70 $ 420
B15 8 174 1,392
E60 5 69 345
G83 9 253 2,277
J34 15 258 3,870
M90 5 121 605
Q70 8 172 1,376
Total ................................................................. $10,285
Computations of unit costs:

A10: $70 = [(4 × $64) + (4 × $70) + (4 × $76)] ÷ (4 + 4 + 4)
B15: $174 = [(8 × $176) + (4 × $158) + (3 × $170) + (6 × $184)] ÷ (8 + 4 + 3 + 6)
E60: $69 = [(3 × $75) + (3 × $65) + (15 × $68) + (9 × $70)] ÷ (3 + 3 + 15 + 9)
G83: $253 = [(7 × $242) + (6 × $250) + (5 × $260) + (10 × $259)] ÷ (7 + 6 + 5 + 10)
J34: $258 = [(12 × $240) + (10 × $246) + (16 × $267) + (16 × $270)] ÷
(12 + 10 + 16 + 16)
M90: $121 = [(2 × $108) + (2 × $110) + (3 × $128) + (3 × $130)] ÷ (2 + 2 + 3 +3)
Q70: $172 = [(5 × $160) + (4 × $170) + (4 × $175) + (7 × $180)] ÷ (5 + 4 + 4 + 7)
4. a. During periods of rising prices, the LIFO method will result in a lesser
amount of inventory, a greater amount of the cost of goods sold, and a
lesser amount of net income than the other two methods. For Amsterdam
Appliances, the LIFO method would be preferred for the current year
since it would result in a lesser amount of income tax.
b. During periods of declining prices, the FIFO method will result in a lesser
amount of net income and would be preferred for income tax purposes.
192
P6–5
Inventory Sheet
December 31, 20Y9
Unit Unit Total
Inventory Cost Market
Description Quantity Price Price Cost Market LCM
112Aa 38 25 $ 80 $ 83 $ 2,000 $2,075
13 78 1,014 1,079
3,014 3,154 $ 3,014
B300t 33 118 115 3,894 3,795 3,795
C39f 41 20 66 64 1,320 1,280
21 70 1,470 1,344
2,790 2,624 2,624
Echo9 125 25 26 3,125 3,250 3,125
F900w 18 10 565 550 5,650 5,500
8 560 4,480 4,400
10,130 9,900 9,900
H687 60 15 15 900 900 900
J023 5 385 390 1,925 1,950 1,925
L33y 375 6 6 2,250 2,250 2,250
R66b 90 80 22 18 1,760 1,440
10 21 210 180
1,970 1,620 1,620
S77x 6 5 250 235 1,250 1,175
1 260 260 235
1,510 1,410 1,410
T882m 130 100 20 18 2,000 1,800
30 19 570 540
2,570 2,340 2,340
Z55p 12 9 750 746 6,750 6,714
3 749 2,247 2,238
8,997 8,952 8,952
Totals $43,075 $42,145 $41,855
193
METRIC-BASED ANALYSIS
MBA 6–1
Transaction Liquidity Metric Profitability Metric
Number of Days’ Sales Return on
Date Description in Receivables Sales
Mar. 18 Collected cash Decrease No effect
18 Wrote off account Decrease Decrease
Aug. 29 Reinstated account Increase Increase
29 Collected cash Decrease No effect
MBA 6–2
Transaction Liquidity Metric Profitability Metric
Date Description in Receivables Sales
July 3 Collected cash Decrease No effect
3 Wrote off account Decrease No effect
Oct. 8 Reinstated account No effect No effect
8 Collected cash Decrease No effect
MBA 6–3
Liquidity Metric Profitability Metric

in Receivables Sales
Decrease Decrease
MBA 6–4
in Inventory Sales
FIFO Higher Higher
LIFO Lower Lower
Instructor Note: The preceding results are based upon a period of rising
prices, which is the case in E6–15.
194
MBA 6–5
in Inventory Sales
Decrease Decrease
MBA 6–6
1. Year 2 Year 1
Accounts receivable turnover:
$233,715 ÷ $33,713 ........................ 6.9
$182,795 ÷ $27,816 ........................ 6.6
2. Days’ sales in receivables:
$33,173 ÷ ($233,715 ÷ 365) ........... 53 days
$27,816 ÷ ($182,795 ÷ 365) ........... 55 days
Alternative computations (small differences may be caused by rounding):
365 days ÷ 6.9 ............................... 53 days
365 days ÷ 6.6 ............................... 55 days
3. Inventory turnover:
$140,089 ÷ $2,230 .......................... 62.8
$112,258 ÷ $1,938 .......................... 57.9
4. Days’ sales in inventory:
$2,230 ÷ ($140,089 ÷ 365) ............. 6 days
$1,938 ÷ ($112,258 ÷ 365) ............. 6 days
365 days ÷ 62.8 ............................. 6 days
365 days ÷ 57.9 ............................. 6 days
5. Return on sales
$71,230 ÷ $233,715 ........................ 30.5%
$52,503 ÷ $182,795 ........................ 28.7%
6. Apple’s accounts receivable turnover in Year 2 of 6.9 has increased slightly
from 6.6 in Year 1. Days’ sales in receivables has decreased from 55 days
to 53 days. This is a favorable change. Likewise, Apple’s inventory turnover
in Year 2 of 62.8 has increased slightly from 57.9 in Year 1. Days’ sales in
inventory has remained the same at 6 days.*
Although Apple is managing its inventory efficiently, it appears that there
could be room for more efficiency in managing its accounts receivable. Credit
terms and comparisons to competitors should be examined to further assess
whether Apple could increase the accounts receivable turnover and reduce
the days’ sales in receivables.
195
MBA 6–6, Concluded
Apple’s return on sales in Year 2 of 30.5% has increased from 28.7% in Year 1.
This a favorable change, but comparison to the industry averages and com-
petitors should be done to better assess Apple's profitability.**
* Days’ sales in inventory has actually decreased in Year 2, but rounding re-
sults in the same days’ sales in inventory as Year 1.
** MBA 6–8 compares Apple to HP.
MBA 6–7
1. Year 2 Year 1
$103,355 ÷ $16,530 ....................... 6.3
$111,454 ÷ $17,899 ....................... 6.2
$16,530 ÷ ($103,355 ÷ 365) ........... 58 days
$17,899 ÷ ($111,454 ÷ 365) .......... 59 days
365 days ÷ 6.3 ............................... 58 days
365 days ÷ 6.2 ............................... 59 days
$78,596 ÷ $6,450 ........................... 12.2
$84,839 ÷ $6,231 ........................... 13.6
$6,450 ÷ ($78,596 ÷ 365) ............... 30 days
$6,231 ÷ ($84,839 ÷ 365) ............... 27 days
365 days ÷ 12.2 ............................. 30 days
365 days ÷ 13.6 ............................. 27 days
5. Return on sales
$5,471 ÷ $103,355 ......................... 5.3%
$7,185 ÷ $111,454 ......................... 6.4%
196
6. HP’s accounts receivable turnover in Year 2 of 6.3 has increased slightly from
6.2 in Year 1. Days’ sales in receivables has decreased from 59 days in Year 1
to 58 days in Year 2. This is a favorable change. HP’s inventory turnover in
Year 2 of 12.2 has decreased from 13.6 in Year 1. As a result, days’ sales in
inventory has increased from 27 days in Year 1 to 30 days in Year 2. This is an
unfavorable change.
There could be room for improving the management of accounts receivable.
Credit terms should be examined and comparisons to competitors should be
made to assess whether HP could increase the accounts receivable turnover
and reduce the days’ sales in receivables. The increasing day’s sales in
inventory and decreasing inventory turnover are also areas of concern.
HP’s return on sales in Year 2 of 5.3% has decreased from 6.4% in Year 1. This
an unfavorable change. The low return on sales is a concern, but comparisons
to the industry average and competitors should be done to better assess HP’s
profitability.*
* MBA 6–8 compares Apple to HP.
MBA 6–8
The results of MBA 6–6 and MBA 6–7 for Apple and HP are summarized below.
Apple HP
Year 2 Year 1 Year 2 Year 1
Accounts receivable turnover................ 6.9 6.6 6.3 6.2
Days’ sales in receivables ...................... 53 55 58 59
Inventory turnover .................................. 62.8 57.9 12.2 13.6
Days’ sales in inventory ......................... 6 6 30 27
Return on sales ....................................... 30.5% 28.7% 5.3% 6.4%
Apple and HP’s accounts receivable turnover and days’ sales in receivables are
comparable. However, Apple has a much higher inventory turnover (62.8 and
57.9) than HP (12.2 and 13.6). As a result, HP has more days’ sales in inventory
(30 and 27 days) than does Apple (6 days). These differences in inventory metrics
probably reflect the strong demand for Apple’s products.
The primary concern for HP is its low return on sales (5.3% and 6.4%) compared
to Apple’s (30.5% and 28.7%). Again, this probably reflects the strong demand for
Apple’s products.
197
MBA 6–9
1. Year 2 Year 1
$139,367 ÷ $10,152 ....................... 13.7
$126,761 ÷ $8,402 ......................... 15.1
$10,152 ÷ ($139,367 ÷ 365) ........... 27 days
$8,402 ÷ ($126,761 ÷ 365) ............ 24 days
365 days ÷ 13.7 ............................. 27 days
365 days ÷ 15.1 ............................. 24 days
$114,000 ÷ $11,488 ....................... 9.9
$102,978 ÷ $11,039 ....................... 9.3
$11,488 ÷ ($114,000 ÷ 365) .......... 37 days
$11,039 ÷ ($102,978 ÷ 365) .......... 39 days
365 days ÷ 9.9 ............................... 37 days
365 days ÷ 9.3 ............................... 39 days
5. Return on sales
$8,799 ÷ $139,367 ......................... 6.3%
$8,037 ÷ $126,761 ......................... 6.3%
6. CVS’s accounts receivable turnover in Year 2 of 13.7 has decreased from 15.1
in Year 1. Days’ sales in receivables has increased from 24 days in Year 1 to
27 days in Year 2. This is an unfavorable change. CVS’s inventory turnover in
Year 2 of 9.9 has increased from 9.3 in Year 1. As a result, days’ sales in
inventory has decreased from 39 days in Year 1 to 37 days in Year 2. This is a
favorable change. CVS’s return on sales remained unchanged from Year 1 to
Year 2.
Credit terms should be examined and comparisons made to competitors and
industry averages to determine if any of the ratios can be improved.
198
MBA 6–10
1. International
Paper Wal-Mart
$23,617 ÷ [($4,058 + $3,414) ÷ 2] ......... 6.3
$484,651 ÷ [($6,677 + $6,778) ÷ 2] ....... 72.0

[($4,058 + $3,414) ÷ 2] ÷
($23,617 ÷ 365) ................................... 57 days
[($6,677 + $6,778) ÷ 2] ÷
($484,651 ÷ 365) ................................. 5 days
Alternate computation (small differences may be caused by rounding):
365 days ÷ 6.3 ...................................... 58 days
365 days ÷ 72.0 .................................... 5 days
$16,254 ÷ [($2,825 + $2,424) ÷ 2] ......... 6.2
$365,086 ÷ [($44,858 + $45,141) ÷ 2] ... 8.1

[($2,825 + $2,424) ÷ 2] ÷
($16,254 ÷ 365) ..................................... 59 days
[($44,858 + $45,141) ÷ 2] ÷
($365,086 ÷ 365) ............................... 45 days
Alternate computation (small differences may be caused by rounding):
365 days ÷ 6.2 ...................................... 59 days
365 days ÷ 8.1 ...................................... 45 days
199
International
Paper Wal-Mart
5. Return on sales
$1,517 ÷ $23,617 .................................. 6.4%
$27,147 ÷ $484,651 .............................. 5.6%
6. International Paper’s accounts receivable turnover of 6.3 is significantly less

than Wal-Mart’s accounts receivable turnover of 72.0. Likewise, International
Paper’s days’ sales in receivables of 58 is significantly more than Wal-Mart’s
days’ sales in receivables of 5. These differences are likely due to Wal-Mart
selling directly to consumers who use cash or credit cards. In contrast,
International Paper sells primarily to other companies.
The inventory turnover and days’ sales in inventory do not differ as significantly
between the two companies. International Paper has a slightly lower inventory
turnover (6.2) and more days’ sales in inventory (59 days) than Wal-Mart’s
inventory turnover (8.1) and days’ sales in inventory (45 days).
Return on sales is slightly more for International Paper (6.4%) than for Wal-Mart
(5.6%).
200
CASES
Case 6–1
By computing interest using a 365-day year for depository accounts (payables),

Sybil is minimizing interest expense to the bank. By computing interest using a
360-day year for loans (receivables), Sybil is maximizing interest revenue to the
bank. However, federal legislation (Truth in Lending Act) requires banks to com-
pute interest on a 365-day year. Hence, Sybil is behaving in an unprofessional
manner.
Case 6–2
Because of the size and number of customers’ accounts, it is probably unreason-

able for Northern Construction Supplies Co. not to allow credit to contractors and
to require cash or credit card payment. To do so, as Janet points out, would
probably cost Northern most of its contractor customers. Thus, Northern is faced
with having to allow credit to its contracting customers.
Many building contractors obtain construction loans from local financial institu-
tions. They are then allowed to draw upon (withdraw) these funds as portions of
the construction are completed. Most of the time, a representative of the financial
institution granting the construction loan must approve the disbursement based
upon an observation of the work to verify that it was actually performed. Building
contractors are, of course, charged interest on the balances withdrawn from their
construction loans. Thus, building contractors have an incentive to delay pay-
ment of construction bills as long as possible. At the same time, it is unreasona-
ble to expect payment from the contractors until the representative of the finan-
cial institution has approved payment. Thus, it is probably reasonable to expect
that accounts will remain open for 30–45 days after the contractor has received
the materials.
The primary problem that Northern Construction Supplies Co. is facing is that
some contractors are apparently abusing Northern’s liberal credit policy. One al-
ternative would be for Northern to allow a discount for payment within 30 days.
For example, Northern might allow a 2% discount if the bill is paid within 30 days.
Credit then might be discontinued for any contractor with a bill outstanding more
than 60 days. This would provide the contractors an incentive to pay their bills
early. That is, a 2% discount for payment 30 days early (the bill must be paid with-
in 60 days) is equivalent to an annual interest rate of 24% (2% × 360 ÷ 30). This
discount rate would easily exceed most interest rates on construction loans.
Such a payment policy would give contractors a “positive” incentive to pay early.
Before initiating such a policy, Northern should consider its effect on profits.
Does the discount offered compensate for the faster collection of accounts
receivable? For example, earlier payments would allow Northern to earn interest
(profit) on the monies received from the contractors.
201
Case 6–2, Concluded
Note: Statement of activity indicates most contractors pay their receivables, but
they just take their time.
An alternative approach would be to charge contractors interest on overdue
accounts. For example, Northern might charge accounts over 60 days past due
interest at 1½% per month (equivalent to approximately 18% per year). This
approach would be more of a “negative” approach to motivating contractors to
pay earlier.
Finally, yet another approach would be to stop extending credit to contractors
who routinely abuse Northern’s liberal credit policy. However, this approach is
more extreme than the preceding two approaches. It might be more appropriate
for contractors who continue to abuse the credit policy after one of the preceding
approaches has been implemented.
Regardless of the approach chosen, exceptions probably should be allowed for
good customers who suffer unusual situations. For example, a contractor’s bill
might be past due because of unforeseen construction problems, such as bad
weather, disagreement on contract specifications, etc.
Case 6–3
Since the title to merchandise shipped FOB shipping point passes to the buyer
when the merchandise is shipped, the shipments made before midnight, Decem-
ber 31, 20Y1, should properly be recorded as sales for the fiscal year ending
December 31, 20Y1. Hence, Gene Lumpkin is behaving in a professional manner.
However, Gene should realize that recording these sales in 20Y1 precludes them
from being recognized as sales in 20Y2. Thus, accelerating the shipment of
orders to increase sales of one period will have the effect of decreasing sales of
the next period.
202
Case 6–4
In developing a response to Evan’s concerns, you should probably first emphas-

ize the practical need for an assumption concerning the flow of cost of goods
purchased and sold. That is, when identical goods are frequently purchased, it
may not be practical to specifically identify each item of inventory. If all the iden-
tical goods were purchased at the same price, it wouldn’t make any difference for
financial reporting purposes which goods we assumed were sold first, second,
etc. However, in most cases, goods are purchased over time at different prices,
and, hence, a need arises to determine which goods are sold so that the price
(cost) of those goods can be matched against the revenues to determine operat-
ing income.
Next, you should emphasize that accounting principles that allow for the physical
flow of the goods may differ from the flow of costs. Specifically, accounting prin-
ciples allow for three cost flow assumptions: first-in, first-out; last-in, first-out;
and average cost. Each of these methods has advantages and disadvantages.
One primary advantage of the last-in, first-out method is that it better matches
current costs (the cost of goods purchased last) with current revenues. There-
fore, the reported operating income is more reflective of current operations and
what might be expected in the future. Another reason that the last-in, first-out me-
thod is often used is that it tends to minimize taxes during periods of price in-
creases. Since for most businesses prices tend to increase, the LIFO method will
generate lower taxes than will the alternative cost flow methods.
The preceding explanation should help Evan better understand LIFO and its impact
on the financial statements and taxes.
203
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Due Date Interest Due at Maturity

a. MGM: 15.9% ($89,602,000 ÷ $562,947,000)

b. IBM: 3.6% ($336,000,000 ÷ $9,426,000,000)

c. Casino operations experience greater bad debt risk since it is difficult to

Statement of Cash Flows

Statement of Cash Flows

Aug. 29. Operating 10,000

Statement of Cash Flows

July 3. Operating 2,500

Statement of Cash Flows

Estimated balance of Allowance for Doubtful Accounts: $97,400

Computed as shown below.

Note: $84,100 = $97,400 – $13,300

a. $172,500 ($34,500,000 × 0.005) c. $258,750 ($34,500,000 × 0.0075)

$108,200 [$120,000 + $16,000 – ($2,780,000 × 1%)]

a. $130,000 [$140,000 + $20,000 – ($3,000,000 × 1%)]

b. $21,800 [($27,800 – $16,000) + ($30,000 – $20,000)]

a. The three different inventories accumulate manufacturing costs as the prod-

b. The description above sounds similar to a manufacturing firm. Raw materials

a. $24,750 (45 units at $550)

1. a. FIFO ending inventory > (greater than) LIFO ending inventory

1. The interest receivable should be reported separately as a current asset. It

2. The allowance for doubtful accounts should be deducted from accounts

A corrected partial balance sheet would be as follows:

The inventory would appear in the Current Assets section, as follows:

30 Zim’s Beauty 1,650 1,650

*$57,100 = $59,350 – $2,250

*$60,000 = $2,400,000 × 2.5%

Statement of Cash Flows

20Y8 Bad debt

Statement of Cash Flows

20Y2 $31,250 ($12,500,000 × 0.0025) $18,450 ($31,250 – $12,800)

b. The balance of Allowance for Doubtful Accounts that should exist at

1. Bad Debt Expense

*Determined by multiplying sales by 0.005 as follows:

1. First-In, First-Out Method

2. Last-In, First-Out Method

3. Weighted Average Cost Method

Computations of unit costs:

Liquidity Metric Profitability Metric

** MBA 6–8 compares Apple to HP.

* MBA 6–8 compares Apple to HP.

2. Days’ sales in receivables:

4. Days’ sales in inventory:

6. International Paper’s accounts receivable turnover of 6.3 is significantly less

By computing interest using a 365-day year for depository accounts (payables),

Because of the size and number of customers’ accounts, it is probably unreason-

In developing a response to Evan’s concerns, you should probably first emphas-

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